AK: Now, I’d like to get you to talk a bit about what’s going on in the business world and in particular your business bank. I notice from your presentation that in 2010 and 2011 you had negative business credit growth in your presentation, bounced back in 2012 to four and a half per cent, but you’re forecasting a decline again in 2013. Your business and private bank profit actually fell in the latest period by four per cent, so that would indicate that things aren’t going well, which is obviously what we’re hearing more generally. So, tell us a little bit about your experience in the business world and your business lending.

IN: Well, overall I think the business credit growth has sort of been going up and down a bit and that’s a function of the fact that there’s volatility out there. I think people have said is this a good time to invest, done a bit of borrowing, seen some negative developments around the world and said "no maybe it’s time to pare back a bit". But overall we’ve definitely seen businesses over the last couple of years deleverage and keep more cash and that’s understandable in light of the environment they live in.

AK: But would you say it’s also distress that’s occurring, not just conscious deleveraging?

IN: What we’re seeing through all the credit metrics and that starts with a provisioning and impairment expenses, et cetera, but also watch list trouble and pared assets, et cetera. All of the credit metrics are very stable, so what we’re not seeing at least through the lens that we look at business is that businesses are only just hanging on and feeling quite distressed. We’re seeing more a sign that there’s not confidence yet sufficiently to make people invest more, but that at least in terms of our customer base the level of stress is not that high.

AK: Your presentation also predicts an increase in business credit growth in 2014 of six to eight per cent. So, what’s that based on?

IN: I should note always in our presentations include our chief economist’s forecasts. Our management tends to be a little bit more pessimistic than our chief economist.

AK: What? So, he’s at six per cent?

IN: He’s at six to eight. I think from the point of view of our expectation we would expect at best the low end of that business credit spectrum, but I will say in Michael Blythe’s defence, he’s reasonably optimistic, but he’s been right more often than wrong over the past few years.

AK: But what do you think though?

IN: If we get up to sort of four, five per cent over the next financial year, so that’s, you know, from June to June, I think that would be a pretty good overall level of system activity.

RG: What you’re really saying is look when they change the government you’re a certainty for to business in business.

IN:No. I’m certainly not saying that. You know, our thesis for quite a while has been volatility makes businesses step back and away and that’s totally understandable and in fact consumers act the same way. The biggest driver in my mind of the volatility has been what we’ve seen overseas, not what we’ve seen in terms of domestic politics. Now, in election years there’s always a level of increased concern in businesses because they’re just waiting for an outcome no matter what the current status quo is, so that I think is another fact that might just subdue some of the business intentions over the coming months.

RG:But you’re expecting that after the election there will be quite a rise in business investment.

IN: Well, I think if we see Europe not produce any more bad news, China continue to do what China’s been doing and the US recovery continues strongly, I think on that basis what we will see is that post election, assuming the election delivers a stable government on either side of the political spectrum, businesses will look around and say "okay now might just be the time, we’re feeling stable enough to invest a bit more for the long term".

SB: Ian, if there were a resumption of strong credit growth, what would your balance sheet look like given that we’ve got far stronger capital and liquidity requirements? Could you actually fund strong credit growth without having to go back to offshore wholesale debt markets?

IN: Well, it’s important to break each of those down. From a capital point of view, absolutely, so in terms of the Basel III capital regime you can see our capital at 10.6. It’s very comfortable. We generated forty basis points in the half, so organic capital generation is strong and we’re very confident from the capital point of view that we can continue fund lending.

In terms of the deposit and wholesale funding side and liquidity management. At the moment our balance sheet is sixty-three per cent deposit funded. We’re very comfortable with that. As it happens, we’ve funded all new lending out of deposits, but that’s not because we chose to, that’s just because deposit growth has been bigger than lending growth and they just match off.

I’ve said on a number of occasions now going back to when I took over the role, it will be very interesting from the point of view of regulators, rating agencies and debt providers, as credit growth starts coming back and arguably system growth and deposit slows, a natural gap between deposits and loans will open up again on banks’ balance sheets and that’s going to cause all of us to think again about what the optimal level of the balance sheet construction is because we won’t be able to rely on just funding new lending out of deposits if we want to fund the lending that Australia is likely to produce.

AK: There’ll have to be a resumption of securitisation, won’t there?

IN: Well, securitisation is starting to resume a little bit now. Now, of course that tends to not be such a strong funding source for the major banks.

AK: No, that’s right – that’s the point.

IN: Yeah. I think from our perspective we’ve always said, and we still believe, that good, well diversified wholesale funding, diversified as to tenor and source is a very stable for the funding, at least as stable as deposits in fact because if you get into problems of liquidity management, term funding you know is there because it hasn’t got a call until the day it’s got a call. So that will absolutely be part of our overall, ongoing funding model, but as I say we’ll need to have ongoing discussions with other stakeholders to make sure everyone’s comfortable with a certain type of composition of the balance sheet.

SB: Last month, Ian, the Basel committee changed the proposed liquidity regime. One of the things they did in that was to allow Residential Mortgage Backed Securities with a discount. APRA doesn’t seem anywhere near as enthusiastic about allowing mortgage backed securities to be used as liquidity for the guidelines. Do you think you will be allowed use RMBS? And if you don’t how do you get to that point where you can actually fund strong credit growth?

IN: Well, there are a number of changes as you identified, Stephen, in terms of what the Basel committee did with liquidity rules. APRA here has sole charge of implementing them in Australia and we have ongoing discussions with APRA about all sorts of different aspects of that – how to categorise different sorts of deposit, what qualifies as liquid assets in terms of committed liquidity facilities, RMBS, etcetera. The final shape of that is not yet known, but I’m very confident – given the nature of the dollar – we have with APRA that the challenges of are there sufficient liquid assets? What counts as liquid assets is very well understood. And I think we’re on track to get to a very pragmatic spot, although I don’t know yet the final answer to that question.

RG: Are you seeing any weakness in deposits as the share market rises and interest rates fall?

IN: We’re starting to see, for example, inflows into Colonial more go into equities than into the cash products which is pretty interesting. That’s a dynamic that we’ve seen over the last couple of months. So far, system deposit growth is remaining pretty solid. There are all sorts of interesting academic debates which no doubt you will all be across about where does the deposit go when it’s pulled out to fund equities because if somebody is selling the share that’s bought, etcetera, but what we have observed over time is that as equity markets start to come back strongly, overall deposit levels do start to fall off a bit. We expect to see that. We haven’t seen any significant signs to date.

AK: Is there a lump or a bulge of term deposits going back to say 2009/10 when people put a lot of money into term deposits which have now… or will mature this year sometime?

IN: No. Most of them tend to be on different sorts of cycles. So, unlike wholesale funding where you sort of have a bigger amount maturing in any given year and that you know is your funding task for the year, deposits are a lot more diversified and people often roll them over on much shorter terms. So, it really tends to be much more a question of consumer preference and behaviour rather than the specifics about any kind of deposit.

SB: If you want to keep those deposits there though, we’re going to have to get used to the notion that that relationship between the cash rate and mortgages on one side and deposits on the other is going to change fundamentally and permanently.

IN: Well, it has changed. And what we’ve pointed out all along is that as people have said 'look what are lending rates doing relative to the cash rate?', we’ve always broadened the debate out to say well let’s have a look at what deposits have done relative to the cash rate as well. The reality is that on both sides of the balance sheet, we’ve seen a very significant divergence in terms of pricing from both loans and deposits and I expect that that will continue. The cash rate is a very important signal, but as you know it’s really only saying what’s the rate the Reserve Bank is going to give banks for giving overnight money and that it sends quite a strong signal to the market but there are all sorts of other forces at play as well.

SB: I suppose what I was trying to get to is, If there is leakage of deposits, continual leakage of deposits into equities or whatever else, is that relationship between the mortgage rate and the deposit rates going to widen?

IN: Well, it all depends. Number one, it’s very important to realise that under a new liquidity regime all deposits are not created equal, so certainly internally in the group, we stopped talking about deposits as a headline number and we speak much more about sticky deposits which have a long behavioural term and are going to be less susceptible to being pulled out at short notice.

But overall I think yes, as you’ve identified, that’s going to be right, we’re going to continue to see a bigger divergence between deposits and the cash rate because as the pull of deposits relative to what the banks want – there’s a certain number – to the extent banks have a desire for more of that in terms of their balance sheet, that obviously competes the price that they will pay for those deposits up.

RG: When does it become sticky? Is it one year? Two years?

IN: In terms of the way we look at it for liquidity management purposes it really is product by product and each product based on all the history that it’s got a behavioural term and that’s the behavioural term that’s used for liquidity management purposes, so it’s actually quite a granular assessment. The easiest way to differentiate here is to say there is a bunch of deposits which are very rate sensitive put with you for days, weeks or months and the moment there’s a better rate they’ll go. Others are very much as part of a core customer relationship and they will stick with you for a long period of time and that could be a year, two years or three years plus.

RG: But the factors in that, what transaction banking and the length of the term deposit?

IN: Transaction banking, the length of the term deposit, the overall relationship between the customer and the financial institution and to some extent, and this is something we believe very strongly, the functionality of that deposit across all sorts of different products. Because our view is if you have the breadth of offering right across the product base, a deposit has got more use to be able to be diversified in different asset classes and that gives people an incentive to keep more with you.

AK: Yeah well, how important in that is the fact that you’re selling 1.9 products per customer which is the most of any bank?

IN: Yeah, it’s 2.9 at the moment. And that’s very important, but we think that’s just the start. I mean the simple thesis for where we believe we can grow is that according to Roy Morgan when researched thirty-three per cent of Australia’s consumers say we’re their main financial institution and we have 2.9 of their products per customer. So, to us it’s actually less. We’ve got 2.9. I think the next best has got 2.84. It’s much more 'what could that 2.9 become with a broader array of wealth management products, insurance products, et cetera?' And that’s a real focus of what we call our one Commbank strategy.

SB: Ian, one more question on the funding issues. Whiletheprogress towards it has been glacial, we are going to get a listed corporate bond market. Do you see that as a potential source of domestic funding to reduce your lines on the wholesale or is it potentially a source of competition to the banks?

IN: Well, it’s both. And going back, you know, five or six years I remember when I joined as Head of Strategy in 2007 there were a lot of discussions going on at the institutional bank about the development of this total capital solution strategy which Ian Saines and his team are in the advanced stages of implementing. And the core of that strategy was to say we need to learn to work with clients who want to access capital markets directly, because increasingly they are going to turn to those markets and not just use our balance sheet. So that was well before the financial crisis. That theory and thinking is still as relevant as ever, so we actually believe they’re an important source of direct funding for our clients. Overall in terms of how banks think about the bond markets, et cetera, a strong, internal domestic fund base is critical for us and that’s another important fact of how that could occur.

RG: Ian, how far ahead of the other banks do you believe you are in technology?

IN: Well, we believe we’re in the strongest position. And in fairness to my colleagues at the other banks they dispute that, but let me tell you the way we think about it. We think the key aspects of our platform are for one, that we’ve got every single customer for deposits and transaction accounts onto a state of the art real time platform. And also, that we’re the only major bank to have that for all our customers across the whole platform – and after five years we’ve migrated the entire legacy bank onto it. That takes an enormous amount of care, a good risk appetite and an enormous amount of money, a huge amount of managerial focus, and that’s in the past. So, if you believe that the capability we have is something banks need, then that takes four or five years to build minimum.

RG: And the others haven’t done that?

IN: And the others haven’t done it.

RG: To what extent is that technology a factor in this profit result?

IN: Look, we were very keen to show the increase in transaction account activity because as a result of of this real time capability that is one area we expect to see the result. So, all businesses and customer deposits are on there. The real time banking enabling merchants to get real time value for depositing their takings with us and use it the minute it’s in the bank, so merchants can deposit their takings in a branch on a Saturday, see it immediately on their iPhone and pay someone with that taking immediately or get value for it immediately, not retrospectively credited seventy-two hours later. So, those sorts of things are starting to show up in the results, as are the first signs of the productivity benefits we’re looking for.

AK: But it’s not showing up in market share yet, is it? And do you expect it to?

IN: Yeah. I mean market share in this environment, given where margins have been, there’s been a lot of competition in different parts. It’s something we haven’t chased for its own sake, so we’ve been very clear over a large number of years that we are very thoughtful about optimising volume and margin. In environments where there have been weaker margins, we’ve been prepared to see the little bit of market share. And so we haven’t set ourselves market share targets, so we’re not forced as a management team to just go out and get them no matter whether or not they create value for our shareholders.

AK: No. But you expect the technology advantages that you’re talking about to turn into market share gains?

IN: Yeah. Over time I expect it will go more to customer preference and this differentiation that we’re talking about will be seen by customers. And we particularly think it’s around this real time capability.

SB: Ian, apart from the competitive advantage and the productivity gains you can get out of the investment in technology, is there a defensive aspect to it as well? I know some bankers, including some of yours, are worried about the Googles of the world, having seen what technology does to establish industries. Is there a defensive aspect to what you’re doing?

IN: Yeah, absolutely. We have a lot of respect for all our competitors, major banks, next tier, et cetera, and we spend a lot of time thinking about them. But we spend an equal time thinking four or five years ahead as to which business models that aren’t currentlyin play and the financial services could become that way. Now, whether it’s Google, Yahoo, Apple, PayPal, or other device manufacturers, you can choose your competitor. All of them at some point have given thought to how they might play in financial services. Their strategies I think are still works in progress, but we feel that it’s very important to have a state of the art technology platform, so we’re able to compete not only with traditional banking models, but increasingly with technology and powered models as they become more significant.

AK: Well, along those lines, how do you regard the near field communication chips that are going into mobile phones that are going to use Google Wallet to just wave your mobile phone at the checkout?

IN: Well, those same chips enable with Commonwealth Bank Kaching and you can wave in Commonwealth Bank Kaching and pay immediately as well. And the advantage we feel we’ve got is, number one, to come back to the point we were talking about before, we’re able to take your deposit and give you value for it because we’re an authorised depository institution. We’re able to take that deposit and give you functionality across wealth management products, home lending products, et cetera. So, our view is as long as we keep up with the basic transactional capability, our benefits as an authorised depository institution and the breadth of services and products we provide should position us pretty well. But we take those sorts of developments very seriously.

RG: Are the other banks in the same situation?

IN: All the other banks are in different situations. I mean I’m not going to lie and say we’re the only ones onto this. I think there are very capable people across all the banks doing a lot of the same thinking and there are very good people in our competitors doing this thinking. Again, we believe that having this big piece of infrastructure in that’s taken us five years to put in positions us pretty well.

RG: Do you think that major Australian corporates, including banks, are making a mistake by heavily offshoring?

IN: Our view on offshoring is simply that we don’t do it. And the reason is because we look at all the numbers showing short-term labour costs arbitrage and they can be very seductive, but we believe you’ve got to look at the long term – and I’m talking ten years out, net of all the operational risks associated with it. Because the reality is that people who are servicing your customers or performing back office services overseas don’t understand our brand as well, don’t understand our market positioning and as good as they are our view is they don’t take the care necessary of our customers, our back office and our data. So, we’re willing to forego the short term benefits because we believe that in the long term we’re better off doing things in Australia. Others make a different choice. I’m not going to say they’re making a mistake, but they’ve obviously done their own analysis and weighted different factors differently.

AK: You’ve been reading Nassim Taleb.

IN: I have on a whole lot of topics, but not on that. But this goes back to, you know, thinking that I’ve been involved in over the last fifteen years on this topic and I feel pretty strongly about it.

RG: And yet a great many Australian companies, including not just banks but others as well, Telstra and other companies, are going deeper and deeper into offshoring.

IN: Look, and many of them are well-managed companies aware to the risks and they’re making their own assessments. So, again it’s a bit like the technology debate. You’ve got a lot of people assessing and weighing up different things. And we’re not going to say we’re definitely right, but we are very confident in the direction that we’re taking.

IN: Look, I’ve got to fear all sorts of tail risks and unknowns. I mean, in terms of what we expect every day, and the world turning out as we expect it will, I’m very confident about where we are across all sorts of dimensions. I’m confident in our brand. I’m very confident in our people. We’ve got a great customer franchise. We’ve got good systems, et cetera. As a bank CEO, while I’ve got fifty thousand people all focused on positioning the bank for that world, together with a small group of people I’ve got to be worried about the what ifs...

RG: The black swans?

IN: Really black swans. As recently as yesterday morning, I was thinking about a couple of these things and I was sending an SMS to our chief risk officer and saying we’ve got to keep writing what we call these black hat papers, which say 'what’s the real downside scenario for Australia, how would we see it, how would it transpire, what would we do?' Not because we believe that’s the base case – because we like this economy – but because we need to be prepared for those things if they happen. And all my worries are around those tail risk scenarios which we have to write and think about and therefore they’re full front in my mind. But I’m pretty confident about the way things are going.

RG: What are the one that worries you most?

IN: Well, I mean at the moment we’ve got unprecedented level of activity by, you know, central banks overseas. To preserve stability in the current crisis they’ve injected enormous amounts of liquidity. They’ve kept interest rates extremely low for a long period of time. They’ve bought back public debt, et cetera.It’s not clear to me or to any of us, I don’t think yet, how, four or five years down the track, this is going to really affect the real economy. What sorts of inflationary pressures are going to be there, et cetera? You know, we’ve spent a lot of time as an industry, as a business community and so on, thinking very short term about what if Greece goes, what if there’s contagion to Spain and Italy, et cetera? What there’s probably been less thinking about to date is four or five years down the track. How do these activities that we haven’t really seen or understood before play out in the long term? And again I’m not an alarmist on it at all. I just think we’ve got to be very prepared for different scenarios around that or that we spend a bunch of our time thinking about it.

RG: Like inflation?

IN: Inflation. What would happen if those inflationary pressures occurred? What would happen if at the same time there was a reduction in terms of trade here? How would that play out in Australia, et cetera? But again that’s not the base case. The base case is very positive, but you asked me what I worry about and I worry about those scenarios.

AK: What about your vulnerability to hacking? I was talking to an expert on this stuff recently who said that if there was another war in the world, the first thing that would happen would be that the combatants, the other side, would disable our banks. They’d come in and they would render your database completely scrambled, so that Commonwealth Bank – and he said the name of the Commonwealth Bank – would be down forever. Do you think about that and prepare for it?

IN: Yeah. There are a number of sort of risks that are germane for banking and one of them is cyber security – another one, for example, is a rogue trader – that I worry about all the time, not specifically, but because I have to and it’s my job and I want people talking about it. In terms of cyber security we invest, as you can imagine, hundreds of millions of dollars, thousands of hours of time thinking about these things. This is one area where there’s a lot of collaboration across the financial system around the world. There’s a lot of collaboration with governments. We all realise how serious it would be to have our cyber security undermined and we give it an enormous amount of thought to it. So yes, we do worry about it. The way we respond to that worry is make sure we’re devoting an enormous amount of resource to minimise the prospect that ever happens.

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